China’s European charm offensive: Silk Road or Silk Rope?

The UK should not imagine that Chinese President Xi Jinping’s October visit means it now has a 'special relationship' with China. The visit was just part of a Chinese charm offensive aimed at the EU. 

Xi Jinping’s state visit to the UK from October 20th-23rd had every possible element of flattery and friendship. The Chancellor of the Exchequer, George Osborne, said before the visit that the UK was China’s “best partner in the West”. Xi told a joint session of Parliament that China and the UK were becoming “an interdependent community of entwined interests”.

China has not, however, singled out the UK for special favours. Chart 1 shows that (even though the UK's trade with China has increased significantly in recent years) Britain is still far from being China’s most important economic partner in Europe.

Chart 1. China's leading EU trade partners, 2013

China is cultivating many European countries: since September 1st 2015, Chinese leaders have met senior representatives of more than 20 EU member-states, as well as at least four European commissioners. That outstrips the amount of senior contact between the US and its European partners over the same period. 

Since Sept 1, #Chinese leaders have met senior representatives of more than 20 #EU member-states

Part of China’s motivation is clearly economic. The EU is China’s largest trading partner (and China is the EU’s second largest trading partner after the US). After decades of fast growth, trade has stagnated since the eurozone crisis began in 2010 (Chart 2). Although Beijing wants its future economic growth to be founded upon domestic consumption more than investment and exports, Chinese experts privately admit that the restructuring needed for this would cause economic dislocation, threatening political stability; better to find new markets or increase exports to existing ones.

Chart 2: EU-China total trade

The search for markets also motivates Xi Jinping’s signature ‘One Belt, One Road’ (OBOR) initiative – designed to create the infrastructure for new land and sea routes between China and Europe (the ‘Silk Road Economic Belt’ and the ‘Maritime Silk Road’ respectively). Large infrastructure projects – whether railways in Central Asia or port facilities around the Indian Ocean – would help China deal with over-production of steel and other products without closing plants and creating unemployment.  

According to a recent report by the Mercator Institute for China Studies and Rhodium Group, China’s annual investment in EU member-states went from virtually zero in the mid-2000s to €14 billion in 2014, with the stock of investment reaching €46 billion. The report projects that the pace of investment will continue to increase. For the EU, the prospect of China investing some of its $3.5 trillion foreign currency reserves in European infrastructure is extremely attractive. The EU-China Summit in Brussels in June agreed to "support synergies" between the Investment Plan for Europe (also known as the Juncker Plan) and OBOR. The Juncker Plan is intended to generate investments of €315 billion over three years, including in infrastructure; China envisages the Asia Infrastructure Investment Bank (AIIB) having $100 billion to put into OBOR-related projects, and has set up a separate $40 billion Silk Road Fund to invest in businesses along the route. The two sides subsequently agreed that the European Commission, the European Investment Bank (EIB) and the Silk Road Fund would identify by December how exactly China could co-operate with the Juncker Plan. 

Potentially, economic co-operation between Europe and China on Silk Road projects could indeed be "all-win", as Chinese leaders describe it. Transit times for goods and agricultural products could be shortened. Central Asian states that have developed little (the hydrocarbon sector aside) since independence from the Soviet Union in 1991 could be connected to global markets. And Europe itself could use Chinese money to boost growth.

The question is whether OBOR is a purely economic project, or has geopolitical overtones. The Chinese are certainly at pains to deny that they have ulterior motives in promoting OBOR. But not everyone is convinced. 

Beijing has sought to allay Russian fears that the Chinese are making a move into Moscow's back-yard. When they met in Moscow in May, Russian President Vladimir Putin and Xi Jinping agreed to co-ordinate the Silk Road Economic Belt and the Russian-led Eurasian Economic Union (whose members include Armenia, Belarus, Kazakhstan and Kyrgyzstan, with Tajikistan to come shortly) – even if neither the Russians nor the Chinese know how exactly to merge two very different concepts. For China, however, a good relationship with Russia is important primarily because it removes a potential obstacle on the road to Europe. 

For at least some Chinese officials, the relationship with Europe is seen through the prism of China’s competition with the US: European participation in the AIIB is a good thing not only because European countries will contribute to the bank’s capital, but because they defied US opposition to join it. The fact that the UK was the first to break ranks, risking its ‘special relationship’ with the US to win a ‘golden era’ with China, may be seen in Beijing as a significant victory. And the OBOR initiative, which China claims will include 65 countries with a total population of 4.4 billion, may have two other benefits for China. 

First, it may serve as a partial counterweight to two US-promoted free trade agreements, the Trans-Pacific Partnership (TPP – 12 countries, 800 million people) and the Transatlantic Trade and Investment Partnership (TTIP – the EU and the US, 820 million people). TPP and TTIP are designed in part to ensure that Western countries rather than China set future global trade standards. If China embeds itself in the economies of members of TTIP or the TPP, it can encourage those countries to look after China’s interests.

Second, it may reduce the incentives for Europe to stand up to China over its claim to the South China Sea: if goods can be transported from East Asia to Europe in larger quantities and more quickly by land than by sea, the importance of the South China Sea to Europe as a trade route would shrink. And then, why put the relationship with Beijing at risk for little practical advantage?

More broadly, China can play member-states off against each other (the Chinese have told countries from Latvia to Spain that they can host the European terminus of the Silk Road), or against the US, to gain international influence. American officials may now admit privately that the US was wrong to try to persuade its European partners not to join the AIIB; but some Europeans regret that the UK chose to move first and on its own to sign up to the Chinese plan, rather than in co-ordination with the rest of the EU. In so doing, the UK gained bilaterally but weakened Europe’s ability to extract concessions from China on the AIIB’s standards of governance and transparency. 

Beijing uses the lure of economic co-operation to discourage European criticism of China's human rights record. Perhaps the scale of Germany’s economic relationship with China means that Beijing cannot object when the Germans raise their concerns; during her visit to Beijing in October, Merkel held a private meeting with human rights activists and dissidents. But China makes life difficult for other European countries when they take too much interest in human rights (relations with Norway have not recovered from the award of the Nobel Peace Prize to the dissident Liu Xiaobo in 2010). Those who prioritise commercial interests, on the other hand, are rewarded: the Chinese state media praised Osborne for not confronting China over human rights, and Cameron was able to claim that up to £40 billion of trade and investment deals had been done as a result of Xi Jinping's visit. 

No use @eu_eeas & @EU_Commission delivering tough msgs to #China if member-states undermine #EU line

The EU needs a strategy to benefit from China's economic strength without losing sight of Europe's interests and values: 

• The most important thing is to have a unified European policy towards China, which takes account of the EU's interest in preserving the global order and principles like freedom of navigation. It is pointless for the European External Action Service and the Commission to deliver tough messages, if individual member-states undermine the EU line in order to gain commercial advantage. Germany shows that it is possible to deliver unpalatable messages to China, as long as the trading relationship is important enough to Beijing; and the collective EU trading relationship is the most important of all.
• The Commission and the European External Action Service should ensure that they have a coherent approach to the OBOR initiative, ideally with one senior figure looking at both its technical aspects and geopolitical implications.
• Europe needs to remember that China is not its only partner in the region. Countries like Japan, South Korea and Vietnam are also important, politically and economically, and have their own interests; the EU should weigh these against its desire to gain Chinese approval and economic benefits.
• The EU should make clear to China that European interests in the South China Sea go beyond free passage for European shipping; the principles of maritime law at stake there have global implications. The EU is right to stay neutral on the substance of claims, but it should back the Philippines in saying that an international tribunal is the right body to adjudicate between claimants.
• The EU should offer advice to ASEAN on practical matters like maritime surveillance and fisheries management in the region, as a way of removing some of the sources of possible clashes.
• China and its neighbours need a multilateral dialogue on the South China Sea. The EU should build on the precedent of the Asia-Europe foreign ministers’ meeting in Luxembourg on November 5th and 6th, where EU ministers discussed the South China Sea in private with counterparts from all the littoral states, including China. 
• The EU should revive efforts to co-ordinate policy towards China with the US. Then-US Secretary of State Hilary Clinton and then-EU High Representative for foreign policy Catherine Ashton issued a statement on the Asia-Pacific region in 2012, setting out a number of shared objectives and calling for regular high-level dialogue; but there has been little subsequent follow-up. The interests of Washington and Brussels will not always coincide, but often they will, whether it is on protection of intellectual property rights, compliance with WTO standards or freedom of navigation. 
• The EU should make sure that it focuses on getting China to meet European standards of economic governance and investment protection, rather than relaxing its standards to attract the Chinese to Europe: no Chinese company should be able to flout EU rules in the way that the Russian gas company Gazprom was able to for many years.

No #Chinese company shld be able to flout #EU rules in the way that #Gazprom was able to for years

The UK should not start acting as China's champion in Europe; but it should pay attention when Xi says that the UK "as an important member of the EU" should play "a more positive and constructive role" in the development of EU-China relations; if the US and China are both urging the UK to remain an active EU member, they must have good reasons. As a state with global political, security and economic interests, Britain should work with partners (particularly Germany, still the member-state with the greatest clout in Beijing) to build a more coherent EU policy towards China. An economic Silk Road between China and Europe could be a boon to both; but the EU should avoid being politically bound to China with a silk rope.

Ian Bond is director of foreign policy at the Centre for European Reform.

Merkel after Paris

In spite of speculation that the German chancellor’s refugee policies may be her downfall, Merkel’s relatively open and liberal stance on refugees makes it easier for her to respond robustly to the attacks in France through security and foreign policy. 

For years, Angela Merkel’s personal popularity ratings have been stratospheric and her Christian Democratic bloc (CDU/CSU) has had a robust lead in opinion polls. But during the refugee crisis, Merkel’s relatively open stance has led to her approval ratings dropping to their lowest level since 2011. Meanwhile the increasingly far-right party Alternative für Deutschland (AfD) has gained in popularity. The terrorist attacks in Paris on November 13th have predictably provoked more criticism of Merkel’s refugee policies. But it would be premature to call time on the Merkel era. The combination of her open rhetoric and harsh measures to limit illegal immigration is allowing the CDU/CSU to maintain its hold over the political centre ground. Polling indicates that support for the Christian Democrats is stabilising, as voters faced with a security crisis rally around their leader. Merkel’s position as party leader and chancellor is not in danger.

In August, 45 per cent of Germans saw more advantages than disadvantages from immigration. This number dropped to 35 per cent in September and has since stayed stable at around that level (37 per cent in November). In light of these figures and weakening poll numbers, sceptics evoke a historical analogy. They recall that former Social Democrat chancellor Gerhard Schröder fell as a result of a reform package to liberalise the labour market that incited rebellion in his party, leading to the rise of the new The Left party. Merkel is looking at a similar rebellion over her policy towards refugees, they say. They point to angry voices on the CDU/CSU’s right wing, who no longer feel represented by their party leader, and to the rise of the AfD.

Up until now, the Christian Democrats have successfully prevented the emergence of a mainstream party to their right for three reasons. First, the CDU and its Bavarian sister party CSU is a broad coalition, with the CSU’s leaders traditionally allaying the anxieties of Germany’s more conservative voters (whether Bavarian or not), while the chancellor has held the centre ground. A few rebelling members of parliament, within limits, is part of this strategy. Even today, 86 per cent of CDU/CSU members are happy with Merkel as chancellor, and 81 per cent want her to run again in 2017. 

Second, party discipline has always been strong in these parties, because they have often prioritised power over ideological purity or costly leadership quarrels. Third, right-wing populist parties have attracted xenophobes, anti-Semites, and nationalists, which quickly taints their brand in a Germany wary of its past. 

But the CDU/CSU faces new challenges. It needs to cover an even wider spectrum than in the past: the middle ground of German politics is more liberal, while far-right voters feel less constrained by the country’s past. Forty-three per cent of Germans see the country’s Willkommenskultur (welcome culture) as too politically correct, according to a poll, and feel they cannot openly express their concerns about the refugee crisis. Such sentiments are a fertile breeding ground for populist parties that claim to be giving a voice to ‘concerned citizens’. The increasingly far-right party AfD has won supporters – enough to win seats in the Bundestag if elections were held today – after transforming itself from  an anti-euro party into an increasingly far-right, nationalist and anti-refugee party. After the terrorist attacks in Paris, polling by the conservative Insa Institute put the AfD as Germany’s third-strongest party for the first time, at more than 10 per cent. 

But AfD cannot threaten Merkel without restraining the xenophobic rhetoric of some of its regional leaders, which is proving difficult. Moreover, even if the AfD entered the Bundestag, it could not seriously harm the CDU/CSU’s prospect of retaining power, nor Merkel’s chances of being re-elected chancellor in 2017. As long as Merkel keeps to the centre ground, the arithmetic of German politics favours the CDU/CSU: the AfD would reduce the relative share of the left parties (SPD, The Greens and The Left) in the Bundestag, making Merkel’s party even more indispensable for any governing coalition. 

The chancellor’s stance on refugees has been less impetuous than many have claimed. Merkel’s approach has been rooted in her usual crisis management strategy. She develops her policies cautiously over time – waiting for a public consensus to form, weighing her political options, and working towards a solution that keeps her in power. As the refugee crisis unfolded, the chancellor initially remained on the sidelines of the debate and only chose to ‘be bold’ when a Willkommenskultur materialised throughout Germany. If she had insisted on traditionally conservative and restrictive policies, she would have vacated the centre ground to the SPD and The Greens. Instead, she integrated many of the more left-wing policies on refugees into a Christian-conservative narrative. This strategy has served her well in the past, on issues such as the introduction of a minimum wage or withdrawal from nuclear power. 

#Merkel has integrated left-wing policies on #refugees into a Christian-conservative narrative

Polls show that the German population’s biggest concerns about refugees are linked to the economic and fiscal impact, followed by worries over heightened competition in the housing market and the influence of Islam in Germany. Merkel knows that Germany has the economic strength to cope with the additional costs of integrating refugees, as a study by DIW, a think-tank, has recently confirmed. Germany is running a budget surplus so it can easily finance expenses such as housing for refugees, as even the fiscally-conservative Bundesbank has recently argued. Moreover, in the current European economic situation of low demand and low inflation, additional spending by Germany is a welcome stimulus. Over the medium term, if Germany manages to integrate refugees into the labour market, its demographic problems could be partially mitigated. 

Merkel’s main objective at the moment is to demonstrate that she is in control. Her relatively open and liberal stance on refugees makes it easier for her to respond robustly to the attacks in France through security and foreign policy. Germany had already implemented tougher rules on refugees, including faster deportation, in October. After Paris, Merkel is aiming for resettlements of refugees currently living in or passing through Turkey according to a specific allocation key. In exchange, Ankara would promise to block refugees outside of that quota from coming to Europe. This policy allows Merkel to limit immigration without imposing an absolute cap that would be difficult to uphold.

#Merkel's liberal stance on refugees makes it easier for her to respond robustly to the #ParisAttacks

In foreign policy, her first step was to offer financial and political incentives to Ankara to help reduce the flow of Syrian refugees. At the G20 summit in Antalya, two days after the attacks in Paris, the chancellor stressed the importance of securing Europe’s external borders and Turkey’s crucial role in the process. Her policy has contributed to the EU turning a blind eye to Turkey’s human rights record – in particular recent attacks on the freedom of the press – and to re-energising Turkey’s accession process. Tougher security policies in Germany, or even German involvement in the war against Daesh, could follow – while the chancellor maintains her open and liberal rhetoric on refugees.

Merkel retains the support of a large part of Germany’s political spectrum. A recent poll found that 60 per cent of Germans believe that no other politician in Germany could do a better job of steering the country through the refugee crisis and responding to the threat of terrorism. She still has room to further tighten policies on refugees, while being more assertive on security and foreign policy. Merkel looks like remaining the EU’s dominant political figure for some time to come.

Christian Odendahl is chief economist and Sophia Besch is the Clara Marina O'Donnell fellow at the Centre for European Reform.

Terrorism in Paris: Aux armes, citoyens?

Western indecision in Syria has allowed Daesh to grow strong, and enabled it to attack Europe. The Western response must be resolute abroad, and subtle at home, if it is to defeat Islamist extremism.

Sometimes an event occurs that should create clarity of purpose and lucidity of priorities. The Paris attacks are such an event. The tragedy must galvanise European and international support for a co-ordinated offensive against Daesh. Yet questions remain about how best to deal with terrorism at home.

France has seen terrorism’s face before: most recently in January, when Charlie Hebdo and a Jewish supermarket were the targets. But never, in modern times, has the soul of France been so thoroughly penetrated. French president Francois Hollande called the terrorist attacks in Paris on November 13th “an act of war” by Daesh, the so-called ‘Islamic State’ terrorist organisation. And France’s first reaction has been war-like: the French air force launched heavy bombing raids on Raqqa, the headquarters of Daesh in Syria, on November 15th. That may bring some satisfaction, though it will not solve the problem of Islamist terrorism in Europe.

Since the start of the campaign against Daesh in September 2014, European governments have believed they could dislodge the ‘Islamic State’ from its sanctuary in Iraq and Syria through airstrikes. Yet Daesh has remained able to plot attacks abroad, attract recruits and gain millions of dollars selling oil. In the past month alone, Daesh has claimed, or is believed to have been behind, successful attacks in Ankara, the Sinai, Beirut and now Paris. This should now focus the attention of governments in the West and elsewhere.

Hollande’s rhetoric is reminiscent of George W Bush’s declaration of a ‘global war on terror’ against Al Qaeda after the 9/11 attacks in 2001. Daesh, in contrast to Al Qaeda in 2001, resembles a state in that it holds territory, which can be conquered. The priority should be to destroy the safe haven Daesh has in Iraq and Syria.

In his speech before the joint session of parliament on November 16th, Hollande told his defence minister to invoke article 42.7 of the Treaty on European Union. This ‘solidarity clause’ obliges other member-states to offer aid “by all the means in their power” in response to an armed attack. The clause has never been invoked before, and so its impact remains to be seen, though an EU military intervention is not likely. At the least, the clause forces traditionally neutral EU member-states, like Austria and Finland, to assist. Additionally, its invocation acknowledges that the EU has an important role to play in the battle against Daesh, especially within Europe’s borders. France would also have every right to invoke NATO’s article 5 — which would declare that it has been the subject of an armed attack, calling on its allies to help it. However, Hollande appears to prefer working through a coalition of the willing, rather than bringing NATO in. NATO’s presence in Syria might complicate any co-operation with Russia. Hollande is also seeking a UN Security Council resolution. If it explicitly mandates the use of force, it would be an additional rallying cry for a broad coalition.

Western airstrikes limited to Iraqi territory have so far been practically useless #ParisAttacks 

Airstrikes, particularly limited to Iraqi territory as many European airstrikes are, have been practically useless. Air power by itself rarely wins wars. If the West can find reliable allies who can fight on the ground (including Kurdish forces, despite Turkish concerns), it should help them to do so. Yet the fight may require Western ‘boots on the ground’. The United States has already decided to send up to 50 Special Forces to fight Daesh. European governments should follow suit.

The lessons of past interventions in Afghanistan, Iraq and Libya are not that the West should never intervene militarily, but that it should not start a war without a plan for the day after. In Syria and Iraq, the day after has to include a political process to end the conflicts that have created the governance vacuum, which Daesh has filled. The difficulty of doing so, of course, should not be under-estimated.

After the #ParisAttacks #Putin may argue that Assad is the answer in Syria. He is not.

Russia’s president Vladimir Putin may argue that Syria’s president Bashar al-Assad is the answer in Syria. He is not. Indeed, Assad has done his best to ensure that Daesh is the only opponent left on the battlefield: Syrian and Russian forces have struck against other groups fighting Assad much more often than against Daesh. Though perhaps not immediately, Assad will have to make way to allow Syria to move towards a more peaceful future. In its response, the West will have to work with many countries that have ulterior motives in Syria, including Russia, Turkey and Saudi Arabia.

Europe must not be taken in by Putin’s suggestion that the West, Russia and Assad are now all on the same side in fighting against terrorism. Putin’s game in Syria is cynical. However, the presence of Russian forces in Syria means that the West has no choice but to co-ordinate with Russia, at least to ensure that Western and Russian aircraft stay out of each other’s way.

Europe must work with Turkey’s president Recep Erdogan: despite European concerns about increased authoritarianism in Turkey, the recent attack in Ankara suggests a convergence of interests to fight Daesh. Western governments have to convince Turkey not to undermine the relatively successful Kurdish fight against Daesh for fear of strengthening Kurdish separatists in Turkey. Aside from the military campaign against Daesh, Europe’s external borders must be better secured, for which Turkey’s co-operation is crucial.

The West also has to reconsider its relationship with Saudi Arabia: many of the most disturbing aspects of Daesh’s behaviour in Iraq and Syria reflect Riyadh’s regional propagation of its intolerant, fundamentalist Wahhabist ideology, including through Saudi-funded mosques and Islamic schools in Western countries. Saudi efforts to stop Daesh and its ideology have so far been half-hearted, as it chooses to prioritise fighting against Iranian-backed rebels in Yemen instead.

Despite the semblance of statehood, Daesh is also a network, and its offshoots have already emerged elsewhere across the Middle East. Assuming it can be defeated in Iraq and Syria, Daesh could well metastasise in Libya, Nigeria, Sinai, Afghanistan or elsewhere in the Levant. Still, it is better to disrupt Daesh and keep it on the run, than allow the benefits of a profitable sanctuary to accrue. This means Europe should prepare for a prolonged fight against the group.

#EU governments must balance the use of force abroad & the rule of law at home #ParisAttacks

European governments must balance the use of force abroad and the need to keep working within the framework of the rule of law at home. Daesh wants Western governments to over-react, thereby polarising communities and mobilising new recruits. Instead, Europe must avoid clamping down hard on Muslim communities. Though politicians like Marine Le Pen, Nigel Farage and Geert Wilders will call for de facto anti-Muslim measures, Europe must stay true to its liberal and tolerant values. Police and security services should respond strongly to populist vigilantes and extremists who may step up violent attacks against Muslim targets.

One of the terrorists that attacked Paris on Friday left a fake Syrian passport behind. He had allegedly used it to enter the EU through Greece. This could well have been a planned move to reignite the already heated debate on Europe’s asylum policies — why would a terrorist leave a passport behind? European governments should not fall into Daesh’s trap by responding with knee-jerk reactions such as closing borders (though border controls may be necessary temporarily, to pursue and apprehend the suspects of the attacks). A ‘fortress Europe’ aimed at keeping out predominantly Muslim refugees would fuel the narrative of European Christians oppressing and fighting against Muslims.

More to the point, closing borders would give a false sense of security. There has always been a risk that jihadists may enter the EU posing as refugees. Identifying and stopping them demands adequate registering and fingerprinting on their arrival in the EU, and intelligence sharing among the 28 member-states, not a closing of the borders. In fact, many European plots have involved terrorists from Western countries. Some members of Daesh are jihadists with French, Belgian or British passports, returning from conflict zones (such as Syria) to strike in their home countries. To close the borders would do nothing to stop them: international law prohibits a country from denying entry to its own nationals — and if they are not spotted and put under surveillance by intelligence services, they can continue their activities unhindered from within their home countries. Others have not even left the country: Daesh propaganda ‘instructs’ its acolytes around the world to carry out attacks in its name.

Like many criminal organisations, Daesh mainly relies on difficult-to-trace internet communications which defy national borders. Instead of seeking false security in national isolation, more — and better — European intelligence and law enforcement co-operation is needed. To that end, the European Parliament should speed up an agreement on the use of passenger data for terrorist investigations (a directive that it has blocked for over four years, over privacy concerns). The EU should also overcome its problems with the US in the field of data sharing and co-ordinate with Washington to get access to US intelligence, including its no-fly lists, which includes known terrorists.

The attacks in Paris show that the Schengen agreements, and particularly the Schengen Information System (SIS) ‒ a database used by European governments to track persons of interest – are still not functioning properly. The SIS could be used in combination with other databases (such as Eurodac, which contains fingerprints of asylum seekers) to verify the identity of those arriving in Europe. The European Parliament has been reluctant to allow the interconnection of several databases for fears of privacy intrusion. It is now time for the Parliament to drop some of these claims and realise that such intelligence may benefit the EU as a whole: should a Schengen crisis emerge, it would challenge the EU project in its entirety. Europe should not dismantle Schengen, but improve it, by processing refugees more effectively, deploying many more border guards at Europe’s outer borders and improving information sharing among the member-states. These measures will be costly and take time to implement. But the EU can no longer accept an external border where massive inflows of third country nationals are dealt with in places which barely have electricity — such as the ‘processing centre’ on the Greek island Leros, where the allegedly fake refugee (on his way to carry-out the suicide attack in Paris) was fingerprinted.

But even if the EU had taken all these steps, the attacks might still not have been prevented. 14 years after 9/11, European governments remain unable to control the drivers of radicalisation in second- and third-generation Western Muslims. That leaves one, burning question: why have European citizens become so attracted to Daesh’s ideology that they are willing to kill, kill themselves and be killed, in its name? That is the clarity we still desperately seek.

Camino Mortera-Martinez is a research fellow and Brussels representative and Rem Korteweg is a senior research fellow at the Centre for European Reform.

In-work benefits for EU migrants: How the British government dug itself into a hole

The UK could make both Britons and EU migrants wait four years before having access to in-work benefits, but the ECJ might still rule it illegal.

Today, David Cameron gave a speech and sent a letter to Donald Tusk, the European Council president, setting out his EU reform demands. Most of the reforms are not surprising, and compromise is achievable. But Cameron appears to be upping the ante on his key demand that is most difficult to achieve: that immigrants from the EU should be denied in-work benefits, such as tax credits and housing benefit, for four years.

#Cameron appears to be upping the ante on his key demand that is most difficult to achieve #CHspeech

The speech was accompanied by some new statistics claiming that 43 per cent of EU migrants receive a UK benefit in the first four years of residence in the country. The 43 per cent figure is surprisingly high, and is based upon administrative data, which is not available to the general public. By contrast, data from the official, publicly available Labour Force Survey, puts the figure at 21 per cent in the first quarter of 2015. The government has made the decision to continue to push for the four-year demand, despite the fact that it would require treaty change, unless similar measures were applied to Britons.

The Centre for European Reform has repeatedly argued that the four-year demand was discriminatory and violated the EU’s treaties. In December 2014, shortly after Cameron’s speech announcing the demand, Camino Mortera-Martinez pointed out that article 45 of the Treaty on the Functioning of the European Union (TFEU) forbids discrimination against workers “as regards employment, remuneration and other conditions of work and employment”. Tax credit payments are dependent on workers’ hours and income, and whether they have children, so restricting them would amount to discrimination between Britons’ and EU immigrants’ income from the same job.

CER has repeatedly argued that the 4-year demand was discriminatory & violated EU treaties #EUref

In May 2015, I noted that this discrimination could be quite large: the new universal credit, which will lump together housing benefit and tax credits, would more than double the income of the average central and east European migrant with a child in the UK. Withdrawing in-work benefits from migrants would lead to many British workers receiving higher incomes than EU immigrants for doing the same job. This is a violation of a founding principle of the EU – that workers and companies should be free to do business anywhere in the single market without discrimination. Would Britain accept the French government applying different income tax rates to French nationals and Britons living in France? No. Discrimination through tax credits amounts to the same thing.

Then why is David Cameron proposing it? At the time of his migration speech, the political context was challenging for No. 10: public hostility to immigration was increasing, and the rise of UKIP fed Tory fears that the party would deprive the Conservatives of a majority at the 2015 election. Cameron wanted ideas that would take the heat out of the migration issue. Open Europe, a think-tank with close links to the Conservatives, came up with one. Damian Chalmers, a professor of EU law at the London School of Economics, and Open Europe’s Stephen Booth, called for a three year pause before EU migrants could access most benefits, to be enshrined in EU law through a new directive. (‘Directives’ are secondary EU legislation that must not conflict with the underlying EU treaties.) They said this had a legal basis, because articles 20 and 21 of the TFEU say the Council of Ministers can make secondary laws on welfare, which seems to suggest that the treaties do not have the final word on the issue. But, as the University of Essex professor Steve Peers wrote at the time, this is true for migrants who do not work in their host state. For those who do work, discrimination is not allowed in the treaties, and secondary laws are only permitted when they accord with TFEU’s article 46, which allows only “measures required to bring about freedom of movement for workers”, not measures that restrict it.

At the time of Cameron’s speech, many Conservatives were demanding quotas to limit the number of EU migrants. Indeed, late drafts of the speech included this demand – despite the fact that it was evidently incompatible with the EU treaties or what Britain’s partners would accept. At the last minute, Angela Merkel, the German chancellor, helped to persuade Cameron to abandon quotas. So Cameron took up Open Europe’s proposal – which they had marketed as a way to “save free movement” by, it was hoped, making the issue less toxic for British voters.

As a result, the four-year waiting period for in-work benefits went into the Conservatives’ election manifesto. Of all the British government’s demands in its EU renegotiation, this is the only one that looks unachievable. One suggestion, floated by government sources in August, might be to act unilaterally, and make a domestic policy change: stop EU migrants from getting in-work benefits for four years as well as Britons between the ages of 18 and 22. On the face of it, this idea might solve the government’s difficulties, but in reality, it is still legally problematic. Since migrants from the EU tend to be older than 22, and more likely to have children than British 18-22 year-olds, the ECJ might rule that the policy amounted to de facto discrimination.

The government may find it somewhat easier to reform rules on out-of-work benefits, payments of child benefit overseas and the right of people from countries joining the EU to work in other member-states, as my colleague Charles Grant explains in his recent analysis of Cameron’s demands. But Cameron has been very specific about what he wants on in-work benefits and his government is now in a difficult position. Free movement is the EU policy that British voters most dislike. Other EU governments, however, will not amend the treaties to accommodate the British. For some, such as Poland, this is because it would be directly against their national interest, and for many, it is because they view the principle of non-discrimination as a central plank of the single market. If treaty change to make discrimination between EU workers legal were put on the table, countries more hostile than the UK to free trade might demand discrimination in other areas – between national and foreign companies, for example – and the single market process could go into reverse.

The only out of #Cameron’s in-work benefits trap is to remove benefits from Britons & #EUmigrants

As my late colleague Philip Whyte put it: “The reality is that the EU keeps its members ‘honest’ by anchoring their behaviour”. The EU limits protectionism by enforcing a body of laws – laws which may not violate treaty principles. Any changes to that fundamental principle of the single market will always be very difficult to make. It appears that the only way out is to withdraw benefits from young Britons as well as EU migrants, and hope that the ECJ rules in favour of the reform.

John Springford is a senior research fellow at the Centre for European Reform.

25 years on: How the euro's architects erred

A quarter of a century after the euro’s conception, the flaws in its design have become apparent. EU leaders have fixed some of them but the euro needs better policies in order to be a successful currency.

It is almost 25 years since European finance ministers, meeting in Rome in December 1990, launched an ‘inter-governmental conference’ on Economic and Monetary Union (EMU). Their work emerged a year later as the Treaty of Maastricht, which set out a roadmap for creating what became the euro.
At that time I was a journalist in Brussels, interviewing many of those involved in the conception of the euro. Most of them assumed that the euro would encourage trade and investment across frontiers, thereby deepening the single market and boosting competition. They thought that an independent European Central Bank (ECB) would keep inflation and interest rates low, encouraging investment and job creation. They were also convinced that the euro would strengthen the political bonds between the European nations.

The euro has in fact delivered real benefits to some of its members, particularly in northern Europe. But since 2010, the euro’s difficulties have forced its supporters to challenge some of their assumptions: the eurozone has under-performed compared with other advanced economies (its output is still below pre-crisis levels); high unemployment in southern Europe has contributed to the rise of populist parties; and countless acrimonious emergency summits have pitted north against south, or more recently, against just Greece. Even in Britain, which has no plans to join the euro, its problems have tarnished the EU’s reputation.

A quarter of a century on, it is worth taking stock of what went wrong with EMU and what its future holds. Were its architects driven by political priorities, at the expense of economic fundamentals? What were the biggest flaws in their plans? And are today’s EU leaders doing enough to save the project?

Nowadays, many people view the euro as the child of a Franco-German bargain over German unification that had little to do with economics. However, EMU was initially an economic project, spurred by the success of the single market programme that Jacques Delors, the president of the European Commission, had launched in 1985.

In 1987 a seminal report by Tommaso Padoa-Schioppa, an Italian economist, had a profound effect on Delors. Padoa-Schioppa predicted that the imminent liberalisation of capital controls, a key part of the single market programme, would destabilise the Exchange Rate Mechanism (ERM) that then linked most EU currencies. He argued that of the three objectives of a stable ERM, free movement of capital and national autonomy on monetary policy, only two were possible at the same time.

Delors feared that if the ERM fell apart – as it very nearly did in 1993 – the single market would be threatened: gyrating currencies could provoke the return of protectionist barriers. He concluded that national monetary policies would have to go and persuaded Chancellor Helmut Kohl of the case for monetary union. In June 1988 the European Council asked Delors to chair a committee of central bank governors that would draw up a plan for EMU. A year later EU leaders endorsed the Delors report – before anyone thought the Berlin Wall might fall.

At the end of that year, when the two halves of Germany were starting to move together, Franҫois Mitterrand, France’s president, made EMU unstoppable: he told Kohl that he would not support reunification unless Germany gave up the Deutschmark (which was very popular with most Germans). The Delors report, amended to reflect German concerns, became the basis of the Maastricht treaty’s provisions on EMU.

Monetary union was driven by the politics not only of reunification but also of the ERM, which had evolved into a German-led system of semi-fixed exchange rates. Realignments of currencies were rare, and whenever the Bundesbank shifted interest rates, for the sake of the German economy, the other central banks in the ERM had to follow suit immediately. France and the other countries, finding this German hegemony unacceptable, saw EMU as a means of curbing it. Yet ironically the euro has now become, to a considerable extent, a means for Germany to cajole the rest of the eurozone to adopt its preferred economic policies.

Design flaws of the #EMU: 1st the #EZ has lacked a system for making fiscal policy counter-cyclical

With hindsight, the plans for EMU had at least five serious design flaws. First, the eurozone has lacked a system for making fiscal policy counter-cyclical. When growing, economies need fiscal discipline, but in recession they need freedom to borrow. Lack of discipline has proved to be a particular problem in Greece. During the Maastricht negotiations, German finance minister Theo Waigel insisted on binding rules on budget deficits, with the prospect of fines for governments that borrowed more than 3 per cent of GDP. A strange alliance of Delors and Norman Lamont, the British finance minister, argued that binding rules would in practice be unenforceable. Lamont trusted financial markets to discipline a country that over-borrowed, by demanding a higher rate of interest. Delors said that a country in difficulties would need credits from the EU, which would then impose conditions, including budget cuts. But they lost the argument.

Waigel was right that the markets were fallible: not believing in the Maastricht treaty’s no-bail-out rule, they went on lending to Greece at almost the same interest rate as they lent to Germany, until 2010. But Delors and Lamont were correct that binding rules were unenforceable; France and Germany first broke the 3 per cent rule in 2003 and many others have done so since.

A second problem is that the plans for monetary union lacked provisions for a ‘banking union’, which is now recognised as an essential component. EMU’s parents failed to foresee that the euro would engender a cross-border intermingling of bank assets and liabilities, with the result that if a large bank or a sovereign government wobbles, the reverberations may destabilise banking systems across the EU. A bank bail-out may affect creditors in several countries and lead to difficult questions on who should pay. Nor did the parents foresee the danger of ‘doom loops’: if a bank holds a lot of debt of its own government, which then in a crisis has to bail out the bank, a vicious circle may destabilise both. Such problems emerged after the financial crisis of 2008, which spurred the eurozone to create a ‘single supervisory mechanism’ and a ‘single resolution mechanism’ – including a small recapitalisation fund – for its banks.

Third, EMU’s architects should have created a lender of last resort – one that, in a crisis of confidence, could stabilise financial markets by lending to governments. In 2012, when there was a danger that the markets would tear apart the euro, the ECB plugged the gap by announcing a scheme known as OMT for buying sovereign bonds. This calmed the markets without being used. Also in 2012, governments set up the European Stability Mechanism (ESM), a €500 billion bail-out fund, which has provided credits to countries in difficulty. And in 2014 the ECB added ‘quantitative easing’ to its armoury, a bond-buying scheme for curbing deflation.

A fourth omission was the absence of any means to ensure that eurozone members adopted structural economic reforms, to prevent their economies diverging. The Maastricht treaty set convergence criteria as conditions for joining the single currency, but those covered only public debt, budget deficits, inflation and exchange rate stability (Delors lost the argument for an unemployment criterion).

At the time, the case for adopting economic rather than financial convergence criteria did not appear strong. The peripheral EU economies were growing faster than those of the core; some of them, including Italy, were enacting painful economic reforms in order to show their fitness for the euro; many people assumed that, since the southern countries would no longer be able to restore competiveness by devaluing, they would have no choice but reform; and the Commission’s own analysis suggested that poorer countries would benefit most from EMU, since their inflation and interest rates would drop rapidly.

And that is what appeared to be happening, at least in the early 2000s, as Greece, Ireland and Spain enjoyed credit-fuelled booms. But these obscured and in some ways worsened the growing divergence of competitiveness between the eurozone’s core and periphery. While the biggest problems have been in the south, France and even the fairly successful Germany have often ignored the Commission’s strictures on reform (Germany still suffers from over-regulated services markets and France from an inflexible labour market).

Flowing from this fourth problem was a fifth: too many countries joined the club too quickly. Karl Otto Pӧhl, the Bundesbank president during the Maastricht negotiations, expressed doubts about letting in the southern Europeans. So did Wolfgang Schäuble, now Germany’s finance minister, who as a senior parliamentarian in 1994 co-authored a paper calling for a group of core countries (but not Italy) to proceed with a single currency and federalism. They were right that several southern economies were not strong enough to flourish in EMU. But such concerns were cast aside in order to satisfy leaders who did not want their countries excluded from this grand prestige project.

Given these design flaws, the euro’s problems in recent years are hardly surprising. But eurozone leaders have taken important steps to make EMU work better, building the ESM, the banking union and OMT. They have done enough to preserve the euro but not to ensure economic growth across the entire monetary union.

An unholy alliance of federalists and eurosceptics argues that only the radical centralisation of economic decision-making in the eurozone’s institutions can ensure its long-term prosperity. But this will not happen in the foreseeable future. There is not enough trust among governments or agreement on what needs doing, and electorates will not support the transfer of substantial new powers to supranational institutions. But in any case the federalists and eurosceptics are mistaken. Though the mutualisation of eurozone sovereign debts or a mechanism for transferring money from north to south would be desirable, such revolutionary steps are not essential. The eurozone can in fact flourish with better policies.

The excessive, German-driven austerity imposed on the peripheral countries – which has led to deflation, shrinking economies and growing debt burdens – needs to be softened (and has already been somewhat softened over the past year). Countries such as Greece, Italy and France need to speed up structural reform. In Greece, public debts are unsustainable and need to be partially written off. In the long run, both the ESM and the bank recapitalisation fund will need more resources. And, crucially, Germany needs to rebalance its own economy: with an extraordinary current account surplus of over 7 per cent of GDP, stemming from low levels of investment and weak domestic consumption, it should be doing much more to generate growth at home and elsewhere in Europe.
When EMU was designed, many Germans feared it would turn into a French-led enterprise, pursuing un-Germanic policies. They need not have worried. The economic weakness of France, the diminished stature of the Commission, the introversion of Britain and the strength of the German economy have combined to leave Berlin in charge.

My biggest worry for the #euro's future is the intellectual isolation of #Germany’s financial elite

My biggest worry for the future of the euro is the intellectual isolation of much of Germany’s financial elite from the rest of the world. The problem is not so much that German policy-makers are wrong on everything – for example they are right that structural reform is essential and that Keynesians can over-prioritise the short term – but rather that some of them think they have little to learn from others. I have heard senior German figures speak of Southern European, French or Anglo-Saxon economic analysis contemptuously. I have also heard them refuse to consider the eurozone’s overall fiscal stance, while insisting that the German, French and Italian economies be treated as separate entities.

What the eurozone needs are not federal institutions – desirable though they might be – so much as a Germany that is more sensitive to its partners’ needs, less arrogant in dealing with them, more open to others’ economic thinking, and more willing to acknowledge that the eurozone economies all affect each other.

Charles Grant is director of the Centre for European Reform. An earlier version of this article appeared in Chatham House’s The World Today, October-November 2015.